All right. Good morning, everyone. Bright and early here in the West Coast. It's 7:00 A.M., but it's already 10:00 A.M. Eastern, so I guess it's not so bad. I'm Kristine Liwag, Morgan Stanley's Aerospace Defense analyst. I'm very excited to host our next panel with FTAI Aviation, Joe Adams, CEO. Joe, welcome.
Thank you.
Before we start, let me read our disclosures. For important disclosures, please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. With that, Joe, maybe I'll pass it on to you for some opening remarks.
Sure. Thanks very much, Kristine, and thanks for having me be back again this year. I think I've been coming here almost 10 years now to this conference. It's a great get-together, great conference, great investors. I really enjoy catching up with everyone. I think we met probably about four or five years ago, I think, when you had your little radio broadcast at Morgan Stanley, and we were talking about, I think it was the first time we started talking about aerospace products. We thought we could grow it from a business that we just began, which we called The Module Factory, which was doing about $50 million of EBITDA to $500 million of EBITDA. I don't remember if you actually said no way, but I sensed that you were thinking no way.
As we've grown that business this year, we're looking at doing $3.5 billion of revenues, over $1 billion of EBITDA, and next year growing further to $4.7 billion of revenue and $1.4 billion of EBITDA. The market acceptance and the market opportunity for that has been much bigger than we expected, and it still has an enormous potential. Essentially, what I think of it as is a better way to do aftermarket engine maintenance. It's a model where we combine the ownership of the engine with the ownership and management of the maintenance facilities, and that gives us a different way of thinking about it, a more efficient way. When you're an owner, you think about maintenance differently. We've designed an extremely efficient production process. We optimize. We call ourselves the zero-waste people. We don't waste hours and cycles.
We have scale so we can buy material, which is a big part of it, flexibly and at very attractive prices. We combine really the opportunity to use every available tool to reduce the cost of maintenance for the owners and the airlines. What that means is then we can go to the airlines and the owners and say, "We have a better value proposition. We can actually save you real money, time and time savings." We can demonstrate a demonstrable benefit to the product, and that's what has really allowed us to grow significantly. We started with the best engines in the world, which I think are the CFM56 and the V2500, and we will expand from there. There are other engines that the same business model will work.
We think of this as a very sustainable and durable way to do engine maintenance. The other part of it is a couple of years ago, we realized that these benefits of owning engines and maintaining yourselves also would allow an owner, like a lessor, to create better returns. We realized that we had the opportunity to set up our own asset management business where we could show the investor, we could demonstrate better returns, do all the engine maintenance through engine exchanges, and allow us to increase our footprint in the industry, which means we look bigger to the customer, we look bigger to the industry. We control a lot of maintenance, and it has huge benefits, and it allowed us to do it using other people's money. It's not a capital-intensive activity for FTAI Aviation.
We think that that combination further propels us, and it gives us extraordinary leverage to continue to grow in multiple directions. Lastly, as you know, we didn't plan on power in the beginning because we didn't know the opportunity would exist in this scale. But when we realized that there's a shortage of blades and vanes for manufacture and people can't produce them fast enough, we started thinking, well, how could you solve that problem? The answer to us was, well, then don't make new blades and vanes. Why don't you take an existing asset and convert it? We looked around and said, what asset is big enough to make a difference to produce gigawatts of power in the aviation industry? There's only one. It's really the CFM56. It happened to be our focus engine.
We owned 1,000 of them, and we said, "This is something we really can do and should do." That became really the third part, and it also has the potential to extend the life of this platform for 20 years and gives us an alternative use for run-out engines. It has also tremendous benefits. All three of these activities really feed each other in a positive way.
That's super helpful, Joe. I will confirm in our first meeting when you did say the first billion-dollar EBITDA, I did not believe you. I think there's a recording of that webcast somewhere in the Morgan Stanley portal. But here you are. You're at $1 billion for aerospace products this year. Maybe we could talk about the different businesses and pieces, right? You have aerospace products, you've got the strategic capital initiative, and then by the way, in addition to power, you've got PMA somewhere in there as well.
Yep.
Can we break down some of these pieces? From my conversations with investors, and when you look at the stock, there's a lot of skepticism regarding your value add. Can we go back to aerospace products and talk about how is your approach to engine maintenance different? The discussion that's happening in the industry, initially, your margins in aerospace products was 40%. In the last few quarters, it's below 30%. Historically, when you look at traditional engine MRO shops, their margins are around mid-teens, and that's for a good shop. Some of the ones that are less efficient, they might be at low double digits.
Yes.
Can you level set us regarding what exactly do you do? How is this different? What's your value add? What is normalized margin for that business?
Sure.
What do you think about market share?
Sure. I guess a lot of things I mentioned in the opening is really to contribute. The value add comes largely from owning the engine, as opposed to other people do maintenance on an engine they do not own, and people are selling parts to someone who has an engine they don't own. The incentive for every other participant or many other participants in the industry is to do more maintenance, is to expand the work scope. As an owner, our incentive is not to do that. It's the opposite. What we did is when we first went into the maintenance business is literally went line by line in every area of expenditure in a shop visit and analyzed how to do that better, how to create additional savings, and how to not waste hours and cycles that could be used in a different combination.
We used to lay out a slide that says, a typical third-party MRO would earn a 15% margin. We believe we can get 15%-25% additional from those efficiencies and optimization strategies, and then an additional 5%-10% from parts savings. Just because we buy better, we have scale, we use service material. We're always developing repairs for our own parts to recycle a part instead of have to buy a new one. So there's tremendous amount of savings and what I would call waste in the industry as it exists today that we've been able to identify and wring out.
The value add comes from us being the owner, and the manifestation of that is it allows us to go to a customer and say, "You tell us what you spend today or have spent historically to put hours and cycles on an engine, and we'll deliver to you a price that's better than that." In addition to being better than that, you don't have to go get spare engines. You don't have to have an engineering team monitor the shop visit when it's in the field, and you don't run the significant risk that the cost ends up being higher than you thought. Because oftentimes an engine goes in the shop and at least half the time, the bill ends up being bigger because there's discoveries on other parts of the engine. Every airline in the world has had bad experiences with engine shop visits.
We go to them and say, "We'll save you time and money, and you don't have to deal with any of those headaches. What don't you like?" And the answer is, people like it a lot. They say, "Where have you been all my life?" The strategic capital part of it also gives you additional leverage because we then can go buy aircraft that are on lease to an airline. Let's say an airline has 50 aircraft on lease. We buy 10 aircraft from a lessor. We go to the airline and say, "Great news. You never have to do another engine shop visit again. All of your engines will be supplied by us through engine exchanges. All you have to do is pay maintenance reserves in, and there's no return compensation fights." The airline says, "Wow, are you kidding? That's amazing.
Why don't I introduce you to the owner of those other 40 aircraft that are on lease so that you could buy them and convert it to that model? Because I much prefer your model." So the value add comes from wringing out efficiencies and then delivering savings. It's basic economics of the business and we see it as very durable. Now, when we started out, if you think about the entire engine market opportunity, there are easy repairs, there are light repairs, there's sometimes recombinations, and then there's full performance restorations. And when we had limited availability and a lot of capability to recombine things, we were able to wring out the highest margins available. As we grew the business, we realized the opportunity set is for everything.
We want to be, someday, go to a customer and say, "You should never have to do another engine shop visit again. We'll do all of it for you." If a customer says that, we say, "Okay, we have the capability. We'd be happy to do that." And some of the bigger airlines that have large fleets are used to getting price discounts. So the combination of changing the mix and also having bigger end customers has led us to the conclusion that we can get more market share by having 30% margins than we would get if we had 40% margins. Either one is possible, but we choose more EBITDA, which we think is more valuable in the long run for the company. That's where we are.
We think that the next two or three years, we would assume that margins are going to be steady at 30% because we have a representative mix today and a lot of large customers. Then maybe out in the future, if we have big enough markets, there's an opportunity to take up price. But again, we're always looking for additional savings on cost side, and we want to keep the customer saying, "This is a great product. Let's do more.
But Joe, what you said about, where have you been all my life comment here, I think that's where some of the investor skepticism is or industry skepticism regarding your approach. If it was so straightforward and just clear, why haven't others done it before? Why aren't they doing it now? Should they start copying your business model? What makes yours more durable than theirs?
Yeah. As I said, the key to it is owning both the asset and the maintenance facility. It's hard because a lot of people who are in the industry have done either one or the other, but not both. Putting them together when we did that was considered risky. No one had taken the approach of, I'm going to do maintenance on my own engine. Nobody developed a skill set to do that. We started from the asset management side of it, but when you look also now at third-party MROs, they don't have asset management functions internally. Until somebody puts the two pieces together in one company, I don't see them having the capability of doing what we do.
The other thing is that if you are in the third-party maintenance business today, you have a lot of customers that you've signed up for long-term contracts to work on their engines. When we bought our engine maintenance facilities, we made a decision we were going to do no third-party work. I remember people thought we were crazy at the time. They said, "Who does that?" I said, "No one." The point was, if we have a scarce asset, which was a mechanic, and we work on a third party's airlines engine, we make $1 an hour from that mechanic. If they worked on our engines, they made $5 an hour for us. I said, "Help me figure this out. I'm struggling." It was obvious that if you have a scarce resource and you have a high-value product, that's where it should go.
That decision was not an easy one, and we bought basically a whole facility, and we had no third-party customers, just FTAI.
Joe, on this maintenance facility, I think one of the underestimated value provided is you went from an asset manager to actually owning an MRO, right?
Yes.
I mean, owning an MRO, you get your hands dirty, you're taking apart engines. It's wrenches versus paper signing. You went from zero market share, zero shop visits, to almost 1,000 modules this year. How hard was that journey? For the most part, from a third-party perspective like mine, it seems like a pretty seamless execution strategy. Can you share with us what it took to get there? You've seen a lot of, and I guess also in the aerospace industry, to go from zero modules to 1,000 modules in four years is a speed and growth that nobody's ever heard of. Can you give us context around that?
Yeah, the capacity exists. When we went out and started doing this, we found that there were a lot of maintenance facilities that had been built once upon a time, either for airlines or other people who thought engine maintenance was easy, then they found it wasn't easy to get other people's business. So there were a lot of facilities that had great tooling and no business. We realized that we bring all the engines, so we have the ability to fill the facilities. So acquiring the facilities at a very attractive price was not as difficult as I would've guessed. There were many locations. If you take Miami, which was a former Pan Am shop once upon a time, Montreal, which was a former Air Canada shop once upon a time, Rome, which was former Alitalia shop once upon a time, they were all empty.
We came in and said, "Great news. We have engines. You don't have to go chase third-party customers. We'll fill it." Then on the production side, I would say we were very concerned when we got in the business because we hadn't done it before, so we're like, "How hard is this going to be?" We sort of went back to basics in that two things we focused a lot on. One of was standardization. So people focused. We got rid of all the other engines they were working on. Some shops had four engines, six engines, and we said, "No, you're just working on CFM56. Not only that, you as a mechanic might only work on the low-pressure turbine for the next six months, just one part of that engine." Then we said, "And guess what?
If you do well and you produce a lot of engines, we'll pay you more." It was sort of like, as I thought about Henry Ford did this 100 and something years ago. Those two things are very basic, but they really work. We doubled the productivity in Miami within a year. Then we realized, well, now the shortage is how do we get more mechanics? Because we can deliver the customer a value product. They want more. We don't have enough people to do it. We realized in Montreal, it's not hard to hire people. It was hard to get them to be productive. What happens is the way the system was set up is you hire somebody, and within a few weeks, they have to read a paper manual and pass a multiple-choice quiz to get to the next step.
A lot of people who are good mechanics aren't really good at paper-based multiple-choice tests. We were losing about half the field. Inside Montreal, people said, "Well, these people are better visual learners. Why don't we use virtual reality headsets to show them the step-by-step process of how to disassemble and reassemble an engine?" We did that. We developed our own product, and our yield went from 50% of the people passing to over 90%. We said, "That makes total sense." We now have created a center of excellence in Montreal for the whole company, and we now have 1,600 employees. People go to Montreal to do some training from Miami, from Rome, soon to be Egypt, soon to be Indonesia. These are great high-paying jobs. There's a learning curve, so you have to bring people along.
That really became how we developed our production strategy. The answer is we have a great team of people. It's not one thing. It's a lot of people contributing. It also gets back to that focus question. It's sort of I was a big believer that if you develop this tool for one engine and you really, really get to be the best in the world, you then are convinced you could do it again. You could do it on another engine, once you have that playbook. But you have to focus. You can't do four engines at once. Those two decisions we made of vertical integration and focus were critical in sort of how we've accelerated the growth.
Moving to a strategic capital initiative, moving the assets off balance sheet and having third-party external money was an accelerant to the business. But you thought you were going to raise $4 billion and you ended up having $6 billion for your first tranche. You're now at SCI II, and you've always told me the second time you're raising, you should be higher than the first one that you did. Can you walk us through the economics from an investor perspective of why they should invest in SCI? Because for you, the economics make sense of why you would have it, and then also for the lessors, you're acquiring assets, they're just changing owners. That seems to make sense. But why would investors give you $6 billion for that and potentially another tranche?
Yeah, no, it's a great question. It's one we thought about early on because unless you have some kind of a differentiating value add, why would we be in the asset management business? The answer was we can create bespoke engine solutions for an owner. What I mean by that is if you go to a third-party MRO and you say, "Rebuild my engine," they will say, "Okay, I'll rebuild it to 10,000 cycles. That's what we do." The owner's like, "Well, what if I want 5,000 cycles?" The answer is, "I can't do that unless you supply me all the parts and the material." It's like, "Oh, okay.
Well, I guess I can't do that." What we've developed is we said, look, if an aircraft we buy is on lease for five years and one engine times out in the middle of that lease, say call it two and a half years, the typical lessor requirement would be to rebuild that engine for another five years. You put a lot of capital in, you do a full performance restoration, and you have five years of life, but you only have two and a half years left on the lease. What we developed is a model that said, no, let's build an engine that will last two and a half years so you invest less capital, and at the end of the lease, you have lower residual value risk. What that does is produce higher returns and lower risk.
I've been in the business a little while, but anytime you tell somebody, "Would you be interested in higher returns with lower risk?" They usually say yes. That really was the simplicity of it was it gets back to the fundamental premise. We can deliver a product that's a better product for after-market engine maintenance, and it works for airlines and owners. That's what we did, and it's sort of like once you lay it out for people, they're like, "That makes total sense. Why shouldn't we do that?"
What's the timeline for SCI II?
We have had a first close and we are buying into FTAI SCI II now. FTAI SCI I was fully invested, the $6 billion, which was another skepticism. First, people said when we launched FTAI SCI that it is fake and it is not real and we will never raise it, and then we raised $6 billion. Then people said, "Oh, you will never deploy it. That is too much capital." We have 300 aircraft that we have bought, which by the way, are actually really good deals. Because the team is aware that if you want to raise fund 2, fund 1 needs to be good, right? We have great returns and we are in the market and fundraising is going very well.
As I said maybe a year or two ago, we want to build a world-class asset management business, and we picked a number of $20 billion as a target just because that sounds like a real business. But $20 billion is nowhere near where it should stop. If it really works, it should work on any aircraft. If you as an owner can solve engine problems better than someone else, you will make more money for people. That means if you make more money for people, you get more to manage. That should be a potentially much, much bigger business.
Joe, I want to save some time to be able to discuss power. But before we move to power, when you think about the business that you have with aerospace products, FTAI SCI I, FTAI SCI II, what is it that you are really building? Also at first when you are a small market share, it seems like the growth is unlimited, but as you do get towards that journey of a $20 billion asset, and also right now your market share is over 10% of the CFM56 and V2500 shop visits. You are becoming a fairly large company. When are you starting to eat into other people's profit pools, and what does that mean for the growth opportunity for your business?
Yeah. I sort of flip it around and think about why shouldn't everyone be doing it this way? Because if literally having your own maintenance capability in-house is a better way of managing it and it gives you higher returns, why shouldn't the entire aftermarket be managed this way? That is the way I think about it, and I do not have any real good answers why not. That is what has given me a lot of hope. If you have a better product that produces better returns and it solves problems for customers, why shouldn't this be the model?
The one thing I would push back on that is, the engine OEMs, let's say CFM, a third of the shop visits are owned by GE, a third by Safran, and they are the OE.
Well-
What's your relationship with the OE?
I would say first of all that for the CFM56, I believe the OEM portion of shop visits is about 20% now, and they definitely set up the platform for that to decline over time. So in the out years it will be very low. What they really designed it for, though, is to keep selling the parts. So as long as they are selling the parts, if they are not doing the maintenance. Remember, the maintenance business is like a labor markup business. If you are making 75%-80% margins on parts, do you really care about the labor markup? I think the business model is designed for them not to do the maintenance in the aftermarket. It is for third parties to do it, but for them to keep selling parts. So it is not a contradiction with the OEMs.
I think it is a different model than what currently is used by third-party MRO shops. But on the other side, when they look at their business, and if I were in their shoes, I would say, "Well, but I have got a backlog of LEAP and GTF business for the next four to five years. So, okay, the CFM56, maybe it is not going to be as good as it would have been otherwise, but I am full, so what is the problem?
That dovetails into your part agreement with GE. How should we think about that?
Yeah. As I said, in the very beginning, our philosophy has been to take the cost spent in an engine shop and literally go line by line and think about what's the best way to drive the cost down in an engine shop. The best way to have lower parts prices is to have choices. We've set ourselves up so that we have the ability to use whatever is the best for the situation and the most flexible. That fundamentally is the way. We set up the company that way. We firmly believe that that's the way to achieve the lowest cost over time, is always have an alternative. I've never been in any business situation where if I didn't have a plan B and the customer knew it, that I ended up with a good deal.
We always have a plan B, and we always have an alternative, and that's fundamentally just the way we're going to continue running the company.
Great. Now on power, Joe, which is pretty topical for a lot of investors. What's your journey? How did you get into the power business? Can you talk about the economics of what you thought you could accomplish with your power approach? What's the technical maturity of Mod-1 as we speak today?
Sure. We have looked at aeroderivatives for over 10 years. We spent a lot of time when we used to own a lot of CF6-80 engines, which is the engine that the next speaker sells, which is in the LM6000. People used to come to us 10 years ago and say, "Well, the LM6000 costs new $25 million, but you can sell me a CF6-80 for $4 million. Why don't you make me one?" We would do the work, and we would look at it and say, "Well, there is other parts you have to add. You need a generator. You need electrical controls, emissions, all this stuff." We did not really have in-house the know-how. Then we would say, "Well, how many CF6-80s can we find to buy to build a business around?" The answer was not many. The business was not driven by data centers.
It was Fukushima, nuclear reactors being offline, things like that. We always sort of passed until two years ago when the data center demand went up. As I said, we realized that the shortage in the market is caused by the lack of capacity to make hot section parts. We then said, "Well, now it makes sense because you could do this in scale, but you have to have an engine you can get enough quantity." It was like the light bulb went on. I said, "Well, of course, it is the CFM56. There are 20,000 of them." We went in-house, and we decided one of the fundamental business approach that I have always followed is do the hard part first. Right? If you do the hard part last, you may end up risking doing a lot of work and then finding you could not do it.
The hard part of that project is taking an aeroderivative, a jet engine, and converting it into a torque device to turn a generator. You take the fan off, you change some of the air flows, and you have to put a new fuel system in. Those are the things we focused on first with an engineering team, firstly, that we had in-house, but secondly, that we hired from the industry. We now have an engineering team in Indianapolis that is 20 people today. The other thing that you have to do when you design and make changes on an engine is test it. If you are trying to do this as a small group team, it is very hard to go to somebody and say, "Could I borrow your test cell for the weekend?
I have a project I am working on." Because people are like, "No." We had the test cell in Montreal, we had the engineering team, and we did the hard part first. We are very happy with the test results from the turbine. The rest of it is buying industrial parts from the market that have been produced for decades. Gearboxes and generators and fuel control systems. That was phase 2, and we decided we could have done that internally, or we could have done it with a partner. We found JERA, who has done it for 20 years, has a lot of manufacturing capacity, and we said, "Let us partner because it will be faster, quicker, customer acceptance will be good, and by the way, they could provide a lower price than we could do ourselves." That really was how it came together.
Then we have, obviously, a launch customer for the first units for next year, which is a validation. We think that this is a continuous improvement business also, where the first year's model is not necessarily going to be what you're going to be producing in three or four years. So we have a project underway to add a combined cycle capability, which generates a much higher efficiency for the unit, and that's project number one. We also believe we've designed a better maintenance system because we put doors in the side of the unit, so you can actually open the doors, forklift in, takes the turbine out. You have a turbine replacement in the field to swap in, so the unit never goes offline for more than 48 hours.
That is unique, which means that one of the big advantages is you don't need a lot of redundancy for our units. Redundancy, if you don't have free and easy access to the grid, you will need a lot of redundancy that's very, very expensive. So we think we have a product that has decades of life and will be a huge add-on for us because no one in the world can produce that turbine at a cost lower than we can.
Joe, for economics, your aerospace product, it used to be 40% EBITDA margin. You're, like, at 28%, 29%, but it seems like 30-plus is the more normalized level for that. How does the economics for power compare to aerospace products? Are all this effort that you're doing worth it versus focusing more energy in expanding your capability in aero?
Yeah. On that question, I think we talked about that in the beginning, and we're able to do both. We had some engineers with in-house knowledge, but we've added a whole team of engineers with power, and so it's really a separate group in the engineering function. We've now acquired capacity for engines, that's 3,000 modules with the addition of Cairo and Indonesia, which encompasses us allocating a certain amount of that for the power project. So we're very comfortable with the capacity and the management of it. In terms of the economics, the economics are attractive. We said we expect ultimately that when we're up and running, we'll have $7 million- $8 million of EBITDA per unit sold, and we're on track.
It's going to come in two different parts because of the joint venture structure. FTAI Aviation will sell a turbine to the joint venture and book 100% of the revenues, 100% of the expenses. The joint venture will sell the finished product to the end customer, and we will record between 25% and 50% of the ownership of that, which then, combined, works out to the $7 million-$8 million per unit.
Great. Also yesterday, you announced a $500 million share buyback authorization. Can you talk about what's the origin story of your buyback? Why buy back now when you've got so many other organic ways to deploy capital? With the recent stock market pullback and your stock pullback, what do you think the market is missing from your story?
Yeah. On the last question, I think that the cases that people have come up with higher fuel prices and the AI question of whether data centers are going to get built in the U.S., people have come up with extreme scenarios on durability issues, like how long is this going to be able to last, which I would characterize as very extreme. When we look at it, we don't agree with those scenarios. As I said, we think we have a long runway for all these businesses, and they continue to grow, but the market doesn't always agree with you. So we look at it and said, "Well, this seems like a great opportunity, very compelling value," and it won't curtail our ability to make growth investments. We'll do both. We've always been, as you know, very pro-growth.
We would never do anything to put ourselves in a position where we're unable to do something we want to do. We're going to manage it so we can actually do both, but take advantage of what I think is very extreme scenarios that are circulating.
Great. We probably have time to take one question from the audience. If you want to raise your hand, we'll give you a mic. Anyone? Well, great. Thank you, Joe. I think this concludes our session on FTAI. Thank you for joining us.